1. Economic Environment

Question 1

What are the three things that Government policy can affect?

Answer 1

Interest rates and currencies
Business and competition
Economic cycles and inflation

Question 2

Why do financial bubbles occur?

Answer 2

A financial bubble occurs where there are high volumes of trade at prices that are at considerable covariance with the intrinsic value of the asset.

Question 3

Why has globalisation led to a decline in manufacturing in the UK?

Answer 3

The developing world is able to make comparable products from a much cheaper cost base.

Question 4

What do the letters GDP stand for?

Answer 4

Gross Domestic Product.

Question 5

Who controls UK monetary policy?

Answer 5

The Bank of England

Question 6

What is known as M0 or narrow money?

Answer 6

This includes notes and coins in circulation, together with operational deposits that banks hold at the Bank of England.

Question 7

What is known as M4 or broad money?

Answer 7

This includes notes and coins in circulation, together with accounts of UK residents with UK banks and building societies and deposits created by banks for their lending activity.

Question 8

What is the lead measure of inflation used by the ONS?

Answer 8

Consumer Price Index including owner occupiers’ housing costs (CPIH).

Question 9

What is the relationship between fixed interest securities and interest rates?

Answer 9

It is an inverse relationship, as one goes up the other goes down

Question 10

What kind of exchange rate mechanism operates in the UK?

Answer 10

A floating exchange rate

Question 11

Into which two parts is the balance of payments for a country broken down?

Answer 11

Current account and capital account

Question 12

What are the two markets in the UK economy that allow investment to take place?

Answer 12

Primary and secondary markets

Question 13

In the early stages of recovery the what happens with the price of fixed interest securities?

Answer 13

The prices should fall due to increasing interest rates.

Question 14

Interest rates target expected inflation up to how many months ahead?

Answer 14

Up to 18 - 24 months ahead

Question 15

In a time of rapid economic expansion, which of the following statements is true in relation to inflation and interest rates?

Answer 15

Both will rise

Question 16

When the rate of GDP growth falls compared with the previous quarter the economy is said to be:

Answer 16

In slowdown

Question 17

What is the definition of recession?

Answer 17

Two sucessive quarters of declining GDP

Question 18

What does ‘visible trade’ mean?

Answer 18

Imports and exports of goods such as oil, raw materials, machinary, white goods and clothing

Question 19

What does ‘easing monetary policy’ mean?

Answer 19

Reduction of short-term interest rates.

Question 20

What is a combination of stagnant growth and inflation mean?

Answer 20

Stagflation

Question 21

Name three types of unemployment

Answer 21

Frictional
Structural
Cyclical

Question 22

Explain the potential impact of rising interest rates upon fixed interest and equities asset classes
(Oct 18 Case Study 3 (b) (i))

Answer 22

Fixed Interest
* yields rise
* capital value falls

Equities
* debt costs rise/lower profitability
* dividends/share prices fall

Question 23

Explain two reasons why a fund may increase its exposure to its
equities and commodities asset classes in response to rising inflation. (Oct 18 Case Study 3 (b) (ii))

Answer 23

*Equities has pricing power/higher profits;
*higher share price.
*Commodities demand increases;
*resulting in higher prices.

Question 24

State three reasons why the price of index-linked fixed interest securities may fall
even if inflation is rising and expected to continue to rise. (Oct 18 Case Study 3 (b) (iii).

Answer 24

*Interest rates rising faster than inflation.
*Increased issuance to fund budget deficit/fiscal policy/supply and demand/
credit downgrade.
*Inflation expectations are falling/lower than expected.
*CPI/RPI difference.

Question 25

Describe briefly what is meant by current account and capital account. (Oct 18 Case Study 3 (c) (i).

Answer 25

Current account
* Imports minus;
* exports/balance of payments;
* in goods & services;
* plus receipt from overseas income generating assets.

Capital account
* Movement of all monies/assets;
* into country;
* out of country.

Question 26

Outline four potential economic consequences of the current account and capital
account being in deficit over the medium to long-term. (Oct 18 Case Study 3 (c) (ii).

Answer 26

• Rising interest rates.
• Economy growth falls.
• Currency devaluation.
• Capital flight out of UK.
• Unemployment rises.
• Inflation increases.

Question 27

What impact does technological change have on the economy and markets?

Answer 27

In general terms, new technology helps existing businesses deliver goods and services more efficiently, and it creates new industries which provide opportunities for investment.

New technologies have had an impact on every part of the running of an organisation including product design, production processes, the location of businesses and the organisational structure as well as enhancing the technical features of products.

It has opened new niches such as mobile telecommunications, and also changed the way companies can do business such as on-line retailing. Globalisation has also been made simpler through instant communications and the ability of foreign producers to bring their products and
services to market more easily. This has opened up further investment opportunities in foreign markets.

Question 28

Write notes to explain the main phases of the economic cycle.

Answer 28

The cycle could start with expansion as the economy recovers from recession. Sales start to improve which encourages firms to employ more people. Reduced unemployment and greater confidence stimulates demand which fuels further growth. Eventually the economy threatens to overheat and interest rates are increased to dampen demand.

A boom period is reached where the economy is growing at its fastest but this tends to eventually slow because of increased inflation and interest rates.

The slowdown or contraction continues and consumers are more cautious leading to reduced sales. Unemployment leads to a further drop in sales. If the slowdown is sufficiently severe it will become a
recession.

In recession, output growth is sluggish leading to both inflation and interest rates falling. A trough is reached eventually which, if it is deep enough, is called a depression.

Question 29

In what way do governments have an impact on the economic cycle?

Answer 29

Historically, governments have tried to create the most favourable conditions for a general election using economic policy. This tends to lead to a boom just before an election and contraction immediately afterwards. Governments have recognised the dangers of manipulating short term interest rates.

Although there have been attempts to put the economy in the hands of central banks, their main tool is the manipulation of interest rates which is not effective when rates are very close to zero.

Also, the government has had to step in during the recession and take back some control by, for example, rescuing some banks.